Cascading Failures in Production Networks

31 Pages Posted: 2 Feb 2017 Last revised: 13 Aug 2017

See all articles by David Baqaee

David Baqaee

London School of Economics and Political Science, Department of International Development, Students

Date Written: September 12, 2016

Abstract

The interaction of input-output networks with industrial structure affects the propagation and amplification of shocks, and is an important consideration for business cycle fluctuations. This paper shows how the extensive margin of entry and exit can greatly amplify idiosyncratic shocks in the presence of a production network and external economies of scale. In this model, sales provide a poor measure of the systemic importance of industries. I derive a new notion of systemic influence called exit centrality that captures how exits in one industry will affect equilibrium output. Exit centrality need not be related to an industry’s sales, size, or prices. Unlike the relevant notions of centrality in standard input-output models, exit centrality depends on the industry’s role as both a supplier and as a consumer of inputs, as well as market structure. Unlike competitive models, vanishingly small industries can have arbitrarily large effects on equilibrium outcomes. Furthermore, the same shock can have both demand-side and supply-side manifestations, depending on the structure of the network.

Keywords: Networks, Sectoral Shocks, Hulten, Input-output, entry-exit

JEL Classification: E10, E30, D50, E20

Suggested Citation

Baqaee, David, Cascading Failures in Production Networks (September 12, 2016). Available at SSRN: https://ssrn.com/abstract=2909868 or http://dx.doi.org/10.2139/ssrn.2909868

David Baqaee (Contact Author)

London School of Economics and Political Science, Department of International Development, Students ( email )

London
United Kingdom

HOME PAGE: http://sites.google.com/site/davidbaqaee/

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